Difference between preliminary and complete valuation?
To find out how the accuracy of valuation in each case relates to actual situations, continue reading.
Most companies need valuations when approaching a crucial decision, like when looking to sell, secure investment, or make long-term plans. The motive is straightforward: to get an accurate estimate of the business value. So, it would help to have various appraisal stages.
An early estimate from preliminary valuations helps when you’re first beginning to consider your possibilities, and a complete valuation is more detailed and includes the impact on the final sale price, which is helpful in important decisions.
Choosing the right one to employ at the right time can considerably alter your business plan. Let’s learn how the aspects of preliminary and complete valuations support and guide your company decisions. To find out how the accuracy of valuation in each case relates to actual situations, continue reading.
What is a preliminary valuation?
A preliminary valuation represents a first estimate of a company’s value. Companies commonly use this method when they are just starting to think about making a decision, as when they have ideas about selling or attempting to draw in investors.
Preliminary valuations are equally important when developing incentive programs for key employees. Businesses can encourage employees to increase the company’s worth through non-qualified deferred compensation plans (stock purchases, stock bonuses, and programs like stock appreciation rights and phantom stock plans). It all depends on your company’s appraisal.
Once you’ve established the present value, these plans can inspire staff members to raise it to the degree necessary for a smooth exit.
Assume that a small startup has started catching the attention of potential investors. It generates revenues of $500K per year and has a 20% EBITDA margin. For the estimation of the preliminary valuation, we will use EBITDA multiple under the Market approach:
Metric | Value |
---|---|
Revenue | $500,000 |
EBITDA (20% margin) | $100,000 |
Industry EBITDA Multiple (EV / EBITDA) | 4x |
Preliminary Valuation | $400,000 |
What is a complete valuation?
Experts in valuation conduct thorough appraisals of companies using various techniques and substantial volumes of financial data to produce complete valuations. By factoring in market conditions, historical and current financial performance, and future growth prospects, the method arrives at a more precise and defensible appraisal for a company or asset.
It is used in M&A documentation, tax assessments, litigation support, and financial reporting. A thorough appraisal aims to provide potential purchasers with an accurate depiction of a company’s worth, such as in an acquisition.
For a mid-sized company, the complete valuation will require the use of multiple valuation methods. In this example, we will use the DCF and Market Comparable methods:
- Discount Rate (d) = 10%
- Terminal Growth Rate (g) = 2%
- Forecast Period = 3 years
Metric | Year 1 | Year 2 | Year 3 |
---|---|---|---|
Revenue | $5,000,000 | $5,500,000 | $6,050,000 |
EBITDA | $1,000,000 | $1,200,000 | $1,400,000 |
Free Cash Flow | $800,000 | $1,000,000 | $1,200,000 |
DCF Calculation:
Year | FCF ($) | Discount Factor (10%) | Discounted FCF ($) |
---|---|---|---|
Year 1 | 800,000 | 0.909 | 727,200 |
Year 2 | 1,000,000 | 0.826 | 826,000 |
Year 3 | 1,200,000 | 0.751 | 901,200 |
Total (FCF) | 2,454,400 | ||
Terminal Value | FCF in Year 3 (1+g) / d-g 1,200,000 (1+0.02) / 0.1-0.02 = 15,300,000 | 0.751 | 11,490,300 |
Total DCF Valuation | 13,944,700 |
Market Comparables:
Company | EBITDA | Enterprise Value | Multiple |
---|---|---|---|
Company A | $1,000,000 | $6,000,000 | 6 |
Company B | $1,500,000 | $7,000,000 | 4.67 |
Company C | $800,000 | $5,500,000 | 6.875 |
Average | 5.85 |
To calculate the Enterprise value of the targeted company under Complete Valuation, we will multiply the average multiple by the current EBITDA of $1,000,000, this will give us a value of $5,850,000
Thus, the valuation derived under the two methods is as follows:
Valuation Method | Value ($) |
---|---|
Discounted Cash Flow (DCF) | 13,944,700 |
Market Comparables | 5,850,000 |
Average Valuation | 9,897,350 |
Key Differences Between Preliminary and Complete Valuation
It’s not just enough to have a thorough understanding of how preliminary and complete valuation work independently. Since each is involved at varying levels of a single big process, you must understand the key differences between the two:
Depth of analysis
Since a preliminary valuation is a quick company estimate, it will look at the most recent financial records.
Let’s say the founder of a small cafe is looking to expand. He can use a preliminary valuation based on his recent transactions and an average value of similar cafes to get a rough estimate. It will help him understand whether he should explore further options or wait longer.
Preliminary Valuation Triggers | Requirements | Result |
---|---|---|
When there is a need for fast decision | Surface level |
A complete valuation requires the appraiser to thoroughly examine records from the past, present, and even projections for the future.
For the same cafe, a complete valuation would be necessary if the founder wants to sell. He would have to involve detailed audits of financial statements, assessment of physical assets, and an in-depth market assessment to get an accurate selling price.
Complete Valuation Triggers | Requirements | Result |
---|---|---|
When there is a need for critical decision | Detailed financial reviews Industry averages Forecasting models Legal considerations Competitive analysis | Thorough Audit-defensible |
Data Requirements
Data requirements for preliminary and complete valuations differ in scope and detail. Here is an overview of the requirements for each;
Data valuation for preliminary valuation | Data requirements for complete valuation |
---|---|
Historical financial statements of the company. It should cover the most recent transactions - typically 3–5 years. | Every data from the preliminary valuation |
The details of top customers/suppliers during the recent period. | Market trends over the years till the current year of operation |
Percent of revenue/expense involving the clients and customers. | Competitor analysis over the years |
Owner expenses as part of running the business | Financial forecast for the upcoming years |
Other discretionary expenses | Backlog or other reports that can track future revenues |
One-time, non-recurring costs that the business paid in the period of appraisal. | Third-party assessments |
Other industry/company-specific information relevant to the operations | Legal documents&Business model and planning over the years. Employee data & Stock agreements |
Reliability and Accuracy
While useful for getting a ballpark figure, preliminary valuations are less reliable for making major financial decisions. They provide a useful estimate, but founders and investors should not solely rely on them for high-stakes decisions. Here are three pointers to remember about preliminary valuation:
- Provides a quick estimate of value, but may not be as reliable or accurate as a complete valuation
- Serves as a starting point for further analysis and negotiations
- Susceptible to changes as more detailed information becomes available
Due to the depth and breadth of data and analysis involved, complete valuations are highly reliable and accurate. Founders and investors can use them for legal proceedings, financial negotiations, and other situations where exact figures are needed.
- Gives a more reliable and accurate value
- Gives a defensible opinion of value to withstand scrutiny
- Considers multiple factors to bring down the risk of over- or undervaluation
Cost and Time
Preliminary valuation is less expensive and can be completed quickly – usually within a few days or weeks. It may not require the involvement of a professional appraisal firm.
Complete valuation is more costly and can cost anywhere between $5,000 to $50,000 or more, depending on the complexity of the business. It takes more time to complete, often several weeks or months and requires the expertise of a professional appraisal firm or specialist.
Let’s summarize these differences here:
Considerations | Preliminary valuation | Complete valuation |
---|---|---|
Depth of analysis | Surface-level, quick assessment | Detailed, comprehensive analysis |
Data requirements | Minimal, basic financials and benchmarks | Extensive, including multi-year financials and market data |
Accuracy and reliability | Suitable for initial estimates | High, suitable for critical decisions |
Cost and time | Lower cost (Usually 60% of complete valuation), faster turnaround | Higher cost, longer duration due to depth |
Preliminary valuations are useful for initial assessments and attracting potential investors, while complete valuations provide a more accurate picture for detailed financial planning and decision-making.
FAQs
Can a preliminary valuation be used for legal purposes?
Preliminary appraisal is a quick estimate of your company’s worth. It involves considering the recent financial transactions and surface level competitive analysis. So, it’s not recommended for legal considerations as it may not serve the purpose due its limited scope.
What information is required for a complete valuation?
A complete valuation requires an extensive array of data like: Detailed financial statements, Market analysis, Operational data, Legal information.
What types of businesses or assets require a complete valuation?
Complete valuations are important for:
- Complex businesses – Those with diverse assets, international operations, or complicated capital structures.
- High-stakes transactions – Businesses preparing for sale, mergers, or large-scale funding rounds.
- Regulated entities – Companies in sectors like banking, healthcare, or utilities that are subject to stringent regulatory oversight.
- Businesses undergoing legal changes – Companies facing legal challenges, ownership disputes, or restructuring.
Can a preliminary valuation impact the outcome of a business deal?
Yes, a preliminary valuation can impact the outcome of a business deal. It may not provide the definitive value needed for negotiations. But, it sets the stage for discussions by drawing initial expectations.
Partner With Eqvista for Audit-defensible Valuation
In this article, we have seen how preliminary and complete valuations work and their differences. To quickly summarize: Preliminary valuation is apt for quick decision making and does not involve much data requirements. But complete valuation will give you a comprehensive analysis of your company’s worth.
At Eqvista, we prioritize quality and timely report delivery, no matter whether the appraisal is preliminary or complete. Our NACVA-certified experts make sure the appraisals are prompt and professional. We used advanced valuation methodologies and scenario modeling to arrive at accurate estimates.
Our valuation reports are thorough and audit-defensible, so you can handle any legal scrutiny with confidence. Reach us out now for a free consultation!
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